The IMF headquarters in Washington DC

The International Monetary Fund was conceived in 1944 during the Bretton Woods agreements. These important talks involved the representatives of 44 countries who were summoned to face the challenge of establishing a reliable international financial system after the market disorders which characterised the years leading to the Great Depression, as well as rebuilding world economy in the aftermath of World War II.

Since then, the structure and role of the IMF have changed, and its size has increased from 44 to 189 member states. Let’s take a look at its history, its functions, and its most striking flaws too.

The International Monetary Fund Basics

● Membership: 186 countries

● Headquarters: Washington, DC

● Executive Board: 24 Directors representing countries or groups of countries

● Staff: approximately 2,360 from 146 countries.

● Total quotas: US$333 billion (as of 2/28/10)

● Additional pledged or committed resources: $600 billion

● Loans committed (as of 2/28/10): US$191 billion, of which US$121 billion have not been drawn

● Biggest borrowers (credit outstanding as of 2/28/10): Romania, Hungary, Ukraine.

The Main Goals and Aims of the IMF

Article I of the Articles of Agreement sets out the IMF’s main goals as:

● promoting international monetary cooperation;

● facilitating the expansion and balanced growth of international trade;

● promoting exchange stability;

● assisting in the establishment of a multilateral system of payments; and

● making resources available (with adequate safeguards) to members experiencing balance of payments difficulties.

Why was the IMF necessary in the first place?

Between the last quarter of the nineteenth century and the First World War, world economy had been characterized by high growth and integration, as well as stability of prices and exchange rates. International trade was growing at a fast pace, and exchanges were regulated through the Gold Standard, meaning that gold was the economic unit of account in international transactions: all payments between countries were made in gold, in terms of which every national currency’s exchange rate was fixed.

During the First World War, the Gold Standard was suspended as currency convertibility was inconsistent with the need of financing the war. Of course, during the war international trade was very limited, resulting in low treasury incomes. In order to finance the war, a solution had to be found, and the only way to solve this problem was by printing currency. However, such inflationary measures were incompatible with fixed exchange rates, therefore foreign exchange markets had to be closed.

In the 1920s, as most countries were completely bankrupt and the global goods market was less integrated, all attempts to re-establish the Gold Standard system failed; after the 1929 bubble, countries tried to solve their insufficient demand problem by pushing exports through competitive deflation and by raising barriers to decrease imports. However, these mercantilistic measures along with floating exchange rates had huge negative effects.

A US poster promoting economic recovery

As every country pushed exports and prevented imports, world trade declined sharply, which caused unemployment and a sharp decline in living standards. This was the grim international scenario on the eve of World War II, and the Bretton Woods system was structured with the precise intention of learning from the mistakes made in the 1930s. The system aimed at reaching a compromise solution between the rigidity of Gold Standard system and the floating exchange rates of the years following the Great Depression.

The role of the IMF during the Bretton Woods System: funding, surveillance, and US hegemony

With Bretton Woods, the International Monetary Fund was established to provide financial assistance to countries experiencing economic hardships; central banks could borrow funds previously deposited with the IMF from all member countries, so the IMF was to be the central bank of central banks, as well as an instrument for economic cooperation between countries.

In addition, the Gold-Dollar Standard was established: countries agreed to fix their exchange rates relative to the US dollar, which in turn was fixed in terms of gold ( 35 dollars an ounce). Slight adjustments in exchange rates of each country could be made only in case of fundamental disequilibrium in the balance of payments, and only with the agreement of the IMF. Therefore, the IMF also held the role of monitoring and supervising economic policies and exchange rate policies to avoid global imbalances, as well as providing a forum for discussion of the most important international economic issues.

This system only really started to work towards the end of the 1950s, as before then most national currencies were too weak to be fully convertible. Furthermore, in its first years, the authority of the IMF was still too weak to prevent countries from pursuing national policies which were not in compliance with the measures established with Bretton Woods and could damage collective interests of members. The optimism surrounding the IMF proved to be ill-founded from the beginning, as deposited funds were insufficient. The IMF was obviously strongly dominated by the United States from the very beginning: the relevance of every country within the Fund was proportional to their contribution in gold and currency. As most countries were bankrupt after World War Two, the United States alone supplied one third of the whole initial deposit. For this reason, the headquarters of the IMF and World Bank were established in Washington.

The United States also held 75% of the world’s gold reserve, which made them, and not the IMF the main suppliers of liquidity. The hegemonic role of the United States was however widely accepted as it brought advantages to all countries;  European and Japanese economies greatly benefited from US imports and US investment, however the United States continued to increase their foreign debt and pursue inflationary policies. This was in order to fund their huge military spending and social reforms, and so discontent became increasingly widespread among Western European countries who were affected by US inflation but nonetheless had to adopt measures to help the US and keep the system working. A particularly harsh challenge to US hegemony came from France, when it decided to exit NATO and to start exchanging its dollar reserve into gold, while openly criticising the US for their “deficit without tears”, meaning that they could allow themselves a huge foreign debt without paying the consequences of it.

The system eventually collapsed in August 1971, when Nixon announced that the US would unilaterally suspend the dollar convertibility into gold, abdicating their central role and marking the end of the Bretton Woods System. Countries slowly went back to a floating exchange rates regime; this was perceived as dangerous by Western European countries for their economies, thus the process of European integration which eventually lead to the formation of the Eurozone was set into motion.

The IMF after Bretton Woods: surveillance, aid to developing countries, the ongoing financial crisis, and criticism

The end of Bretton Woods also downsized the lending role of the IMF, as requests for funds from advanced countries started to decrease and eventually came to an end in 1983. Since then, and until the ongoing crisis, no industrialised country has appealed to IMF funds ever again. In order to stabilise exchange rates and prevent countries from going back to pursuing competitive deflation policies, the IMF increased its surveillance functions.

IMF voting powers

The importance of the IMF in managing global financial crises came to light during the 1980s debt crisis – kick-started by the 1970s oil shocks – which reached immense proportions and involved several developing countries, mostly in Latin America. Their foreign debt had exceeded their earning power, and they were not able to repay it. The IMF quickly put together a funding plan to be offered to Mexico as well as Brazil, Argentina and the other affected countries, on the condition that national private banks should agreed to negotiate a solution with the Fund to restructure the countries’ foreign debt.

However, the IMF’s estimation of crisis management turned out to be too optimistic: production dropped, inflation rose twice more than expected, restructuring plans were not respected by governments, and the poorer strata of population payed for this. Criticism of the IMF rose again, as it was accused of protecting the interests of international banks rather than those of the countries in need of help; this pushed the IMF to create in 1986 the Structural Adjustment Facility. This long-term subsidised loan plan became the IMF’s main instrument to provide help to the poorest developing countries, which has become one of the Fund’s main tasks since the 1980s.

After the fall of the Soviet Bloc, the IMF also provided assistance to the emerging eastern European countries through the tough process of transition to market economy. It also provided aid during the recurring financial crises which have become more frequent since the 1990s, due to financial globalization, and which have always been particularly severe in emerging countries.

The gravity and frequency of these crises have put into question the ability of the IMF to forecast and prevent them. Another important reason for criticism of the IMF regards the effective benefits of the restructuring programs offered to developing countries. In some cases this seems to have made the situation worse at the expense of the local population, due to the attempt to reduce government borrowing which means higher taxes and lower public spending. Nobel Economic Prize winner Joseph Stiglitz pointed out how the macroeconomic policies imposed by the IMF (especially to Southeast Asian countries) during the 1997 crisis, in fact worsened recession and unemployment, whilst increasing the countries’ foreign debt due to high interest rates.

Echoing his view, Noam Chomsky went further by indicating how the IMF tends to apply double standards, by prescribing completely different policies when crises strike advaced rather then developing countries. Referring to the IMF policies regarding the current financial crisis, he stated: “When so-called developing countries have a financial crisis, the IMF rules are: raise interest rates, cut down economic growth, tighten the belt, pay off your debts (to us), privatize, and so on. That’s the opposite of what’s prescribed here. What’s prescribed here is lower interest rates, pour government money into stimulating the economy, nationalize (but don’t use the word), and so on. So yes, there’s one set of rules for the weak and a different set of rules for the powerful. There’s nothing novel about that”.

He goes on to describe the IMF as a “branch of the U.S. Treasury Department” which mainly protects the interests of lenders and investors of advanced countries, at the expense of poorest strata of populations in developing countries. Other critics point to the lack of transparency and for imposing policies with little or no consultation with affected countries.  Jeffrey Sachs, head of the Harvard Institute for International Development points out: “It defies logic to believe the small group of 1,000 economists on 19th Street in Washington should dictate the economic conditions of life to 75 developing countries with around 1.4 billion people.”

Last but not least, the harshest criticism of the IMF regards the immorality rather than the efficiency of certain IMF policies: a 2005 documentary entitled “The Debt of Dictators” explores the lending of billions of dollars by the IMF, World Bank and other international financial institutions to brutal dictatorships friendly to American corporations.

The Debt of Dictators